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Fintech Regulatory Developments: 2017 Year in Review

December 29, 2017

As predicted in our 2016 year-end report, 2017 proved to be a busy year for Fintech in Canada, with a number of important regulatory developments. With the dawn of 2018, we look back to summarize some of 2017’s most notable Fintech regulatory developments in Canada, as well as developments to watch for in 2018.

What We Saw in 2017

Launch of CSA regulatory sandbox – On February 23, 2017, the Canadian Securities Administrators (“CSA”) announced the launch of a regulatory sandbox aimed at supporting Fintech businesses through a more tailored approach to regulation that balances innovation and appropriate investor protection. Following the launch of the CSA regulatory sandbox, the Ontario Securities Commission (“OSC”) announced that its OSC LaunchPad has been made a permanent fixture of the OSC. The Government of Ontario has also expressed its intent to launch a Regulatory Super Sandbox and an Ontario Fintech Accelerator Office. In addition, Québec’s Autorité des marchés financiers (“AMF”) created a new position (Director, Fintech and Innovation) to co-ordinate the work of its Fintech Working Group, which includes six major projects: (i) blockchain technology; (ii) mobile payment solutions and virtual currencies; (iii) fundraising platforms; (iv) automated insurance and investment tools; (v) Regtech; and (vi) Big Data and connected devices.

National retail payments framework review – On July 7, 2017, the Department of Finance Canada (“Finance Canada”) issued a consultation paper proposing a federal oversight framework for retail payments. The consultation paper proposed a functional approach to the regulation of retail payments in Canada, applicable to payment service providers, including many types of Fintech entities in the payment space as well as entities that are already regulated, such as banks and credit unions.

Federal financial sector framework review – On August 11, 2017, Finance Canada released its second consultation paper concerning the review of the federal financial sector framework, in connection with the 2019 Bank Act review. The consultation paper raised a number of Fintech related matters, including whether there was a need to clarify the Fintech business powers of financial institutions, whether there was any need for amendments to the Bank Act to facilitate Fintech collaboration (such as by providing additional flexibility to financial institutions to make non-controlling investments in Fintech entities) and whether the bank entry and exit framework should be streamlined. In addition, the paper stated that the Department of Finance Canada would be examining the merits of open banking, including consideration of how other jurisdictions are implementing open banking and the potential benefits and risks for Canadians. Issues that are key elsewhere (and would likely be key in Canada) are considerations around privacy and data protection, data ownership, cybersecurity issues raised by an open or partially-open environment (including consideration of uniform technical standards), and liability allocation. The paper also sought views on whether non-banks should be permitted to use the terms “bank”, “banker” and “banking” following the issuance by OSFI of OSFI Advisory 2017-01 providing additional guidance on its interpretation of such terms.

Competition Bureau report – On November 6, 2017, the federal Competition Bureau released a draft report on its market study into technology-led innovation, namely Fintech innovation, in the Canadian financial services sector. The report is intended as guidance for financial services regulators and policymakers with the key message that, while Fintech regulation is necessary to protect the safety, soundness, and security of the financial system, regulation should not unnecessarily impede competition and innovation in financial services. The final report was issued on December 14, 2017.

Competition and Big Data – There were two significant developments dealing with Big Data during 2017. While of importance generally, they will be of particular note to those in the Fintech ecosystem as new and emerging business models seek to leverage and/or monetize large data sets and data analytics. The first development was the release, on September 18, 2017, of the Competition Bureau’s white paper for public consultation titled “Big data and Innovation: Implications for competition policy in Canada”. The white paper draws from the Competition Bureau’s recent abuse of dominance investigations involving big data considerations, and also considers US and European developments in order to identify challenges raised by big data. The second development was the much-anticipated decision of the Federal Court of Appeal in the Toronto Real Estate Board (“TREB”) case, in which the Court found TREB was abusing its dominant position. While raising numerous competition law issues, the TREB case fundamentally determined that an organization could be found to be engaged in an anti-competitive practice when it restricts access to data (in this case, home-sales data). Although dealing specifically with the data held by TREB in the GTA, the case is seen as precedent-setting as it has the potential to be a significant factor driving the opening up of data sources in other sectors, notably financial services.

Payments modernization – Payments Canada is in the process of its multiyear payments modernization project, which involves building a new core clearing and settlement system, establishing real-time payment capability, enhancing automated funds transfer (including transitioning to the ISO 20022 standard), aligning with global regulatory standards and modernizing the rules framework. Payments Canada released its Modernization Target State in December 2017 providing further detail on the project and outlining its plan to create a three-system end state consisting of (1) a new high-value system (Lynx) to replace the current Large Value Transfer System (LVTS), (2) a batch system (Settlement Optimization Engine (SEO)) to replace the current Automated Clearing Settlement System (ACSS) and (3) a new real time system (the Real-Time Rail (RTR)) for real-time delivery of low value payments. All three systems will be built to support ISO 20022. Prudentially regulated financial institutions will have direct access to Lynx and SEO while both prudentially regulated financial institutions and non-financial institutions (such as payment service providers (PSPs)) who meet necessary access criteria will have access to the RTR. The RTR will also be built to provide for overlay services through application programming interfaces (APIs).

Project Jasper – In June 2017, the Bank of Canada issued a report on the preliminary findings of Project Jasper, its initiative to learn more about the viability of distributed ledger technology (“DLT”) as the basis for a wholesale payment system. While the experiment revealed that DLT is not presently more beneficial than the current centralized system of wholesale payments, it uncovered other opportunities for the implementation of DLT within the financial industry. The preliminary findings of this report were expanded on September 29, 2017, when the Bank of Canada released a white paper outlining detailed findings from Project Jasper. The white paper noted that settlement finality and low operational risk were key challenges in the first and second phases of the DLT experiment. As of October 17, 2017, the Bank of Canada embarked on the third and final phase of the experiment to develop a proof of concept for the clearing and settling of securities. The results of this final phase are expected to be released at the Payments Canada Summit in May 2018.

Cryptocurrency securities developments

Application of securities laws – The OSC issued a press release on March 8, 2017 advising stakeholders that Ontario securities law may apply to any use of DLT, such as blockchain, as part of financial products or service offerings. On August 24, 2017, the CSA weighed-in on the applicability of Canadian securities laws to cryptocurrencies in its release of CSA Staff Notice 46-307 – Cryptocurrency Offerings. The effect of the Notice is to confirm the potential applicability of Canadian securities laws to cryptocurrencies and related trading and marketplace operations and to provide guidance on analyzing these requirements.

Registrations and exemptions – In British Columbia, the British Columbia Securities Commission (“BCSC”) announced on September 6, 2017 the first registration of an investment fund manager in Canada dedicated solely to cryptocurrency investments. The registrant, also registered as an exempt market dealer, will operate a bitcoin investment fund. In August 2015, Québec’s Autorité des marchés financiers approved an initial coin offering (“ICO” or “ITO”) by Impak Finance, making it the first such legal ICO authorized in Canada. Impak was admitted to the regulatory sandbox for two years and only allowed to sell to accredited investors. In October 2017, the OSC approved the first ICO open to retail investors, who can invest up to $2,500 in the tokens offered. The applicant, TokenFunder Inc. (“TokenFunder”), was a blockchain business seeking to offer a technology platform for businesses to raise capital through tokens, coins and other blockchain-based securities. The OSC granted exemptive relief granted based on TokenFunder agreeing to seek registration promptly following the ICO.

Cryptocurrency futures – Futures trading on Bitcoin was introduced on December 10, 2017 by the Chicago Board Options Exchange (Cboe), and the CME Group followed, bringing bitcoin and cryptocurrencies in general, a step further toward the mainstream and bitcoin to a record high on December 18, 2017 of over $19,850. Regulators quickly reacted: (i) the U.S. Commodity and Futures Trading Commission (CFTC) is requesting comments on certain questions related to its treatment of cryptocurrency transactions, including margin requirement; (ii) on December 11, 2017, the Investment Industry Regulatory Organization of Canada (IIROC) announced greater margin requirements for cryptocurrency futures contracts that trade on commodity futures exchanges; and (iii) on December 18, 2017, the CSA issued a warning to remind dealers and investors about the inherent risks associated with products linked to cryptocurrencies (including futures), such as bitcoin.

Securities commission hackathons – Building on the success of the OSC hackathon in November 2016, which brought together members of the Fintech community to find solutions to regulatory problems arising in the area of RegTech, similar hackathons were held this year in both Québec and BC.

What to Watch for in 2018

Amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the “PCMLTFA”) are expected to be introduced in 2018 in respect of, among other things, open loop prepaid cards and virtual currencies. In particular, the PCMLTFA was previously amended in 2014 to specifically extend the definition of “money services businesses” to include “persons dealing in virtual currencies”, but the regulations implementing this change remain outstanding, even as cryptocurrencies have become more popular.

Further development/ consultations may take place in respect of the national retail payments framework and the federal financial sector framework. We would also expect further developments on the provincial side, including with respect to the Ontario Regulatory Super Sandbox and an Ontario Fintech Accelerator Office.

We expect to see Fintech companies continue to explore admission to securities regulatory sandboxes in order to tap into the Canadian investor base.

In 2018 we may start to see the launch in Canada of blockchain applications that have been in the pilot phase, including in respect of loyalty points, cross-border payments and digital identity. Project Jasper’s Phase 3 results are also expected to be released at the Payments Canada Summit in May 2018.

We expect to see cryptocurrencies becoming more mainstream and being increasingly used as traditional financial assets, including in exchange traded funds (ETFs).

We expect Canadian securities regulators to increasingly (a) monitor ICOs that are, directly or indirectly, marketed or sold to Canadians without the appropriate registration or exemptive relief, (b) cooperate with securities regulators in other jurisdictions, and (c) initiate enforcement proceedings or seek emergency orders against individuals and companies associated with ICOs that are alleged to have violated applicable securities laws. For instance, in July 2017, Quebec’s AMF granted a freeze asset order against the principals of, and the companies associated with, “PlexCoin” and enjoined them from all investment-related activities targeting Quebec residents. When the respondents continued to market and solicit investments in PlexCoin, Quebec’s Superior Court declared them in contempt of court and issued a two-month prison sentence and a fine of $110,000. Then on December 1, 2017, the US Securities and Exchange Commission obtained an emergency freeze order and filed charges against many of the same PlexCoin respondents for allegedly violating U.S. securities laws and defrauding investors.

We may also see class actions in Canada in 2018 in respect of ICOs. In the past few months, class actions have been filed in the U.S. relating to the ICOs of Tezos, Centra and ATBCoin. ICO class actions can be expected to allege (a) that the token should be considered a security, (b) breaches of applicable securities laws, (c) misrepresentations and/or fraud relating to the marketing and sale of the token, regardless of whether the token is a security, (d) personal liability against the principals, advisors and promoters of the ICO, and (e) the culpability of any “deep pockets” associated with the ICO.

Leave to appeal to the Supreme Court of Canada in the TREB case will be sought, and given what is at stake (access to data), we expect to see a wide variety of organizations line up as intervenors if leave is granted. We also expect to see further and more rapid developments in open data (and open banking-like developments) in Canada.